CBDC or stablecoins: Why traditional banks must adopt a new and adaptable policy

The inception of Central Bank Digital Currency (or CBDC) and stablecoins are major proof that cryptocurrency is here to stay. While CBDCs are issued by the government, stablecoins, on the other hand, are issued privately to facilitate a blockchain initiative. 

However, while both CBDC and stablecoins are fundamentally used for the same purposes, the major difference between them is the issuing authority which is either centralised or decentralised. 

For instance, CBDCs are government-issued and as such are regulated by a centralised authority. On the other hand, stablecoins do not operate in the same manner; instead, they exist across a distributed, and decentralised blockchain network.

Unlike other crypto-assets such as Bitcoin (BTC), Ethereum (Ether) and Solana (SOL) that are highly volatile, CBDCs and stablecoins are a much better alternative to fiat currencies. Specifically, CBDCs are as good as a nation’s fiat currency, only that they operate on-chain. 

Stablecoins, on the other hand, are wrapped currencies, meaning their value is tied to another cryptocurrency, fiat currency, or an exchange-traded commodity. 

In this context, we are referring to stablecoins that are pegged to the value of fiat currencies. For instance, a unit of Tether (USDT), USD Coin (USDC), or Binance USD (BUSD), is worth approximately $1, implying that they would function typically as a digital USD would.

That said, how does the digitalisation of financial services especially in the area of currency distribution affect traditional banks and their existing policies?

While some traditional banks are proactive in how they address the mainstream adoption of cryptocurrency, the vast majority are only just waking up to the reality. For instance, banks like JPMorgan, Goldman Sachs, Revolut, and a couple of others have either adopted cryptocurrency as a mode of payment or have gone ahead to create their own digital coin for payment.

On the other hand, some banks are yet to register their attendance in the crypto space and, in other situations, governments have made the process of crypto adoption for traditional banks a miserable experience. Notable examples include Nigeria, China, Qatar, Egypt, and Morroco to mention a few.

The world is getting to the point where banks must open up to the emerging crypto industry otherwise they stand to face a lot of uncertainty in the ever-changing world of finance.

In its latest global regulatory outlook report, Ernst & Young (EY) recommended for banks to adjust their regulatory perimeter to accommodate the incoming launches of state-backed central bank digital currencies (CBDC) and private stablecoins.

According to the report, digitisation is transforming the global financial environment in significant ways, with one of the most vital areas being the provision and facilitation of digital currency.

However, not discarding concerns relating to consumer protection and money laundering, the report revealed that customers’ appetites in gaining exposure to digital assets might outperform the firm’s internal control environment. Consequently, the need for traditional banking firms to re-evaluate their regulatory parameters is now more essential than ever.

Another major concern that was raised is the fact that retail banks may forfeit a lot of customers should they decide to adopt CBDC which appears to be a safer option for those who have little or no risk appetite but are willing to go the digital route. 

“If customers can keep their money with a central bank, they have no need for a retail bank, and firms will see their interest rate margins contract precipitously,” the report reads in part.

Furthermore, the report also revealed to what extent the incoming evolution may impact traditional retail banking, stating: “The macroprudential or international implications of a major currency having a retail coin could be very significant for retail banks and the dollarisation of smaller economies.”

The implication of the above is that most central banks are likely to pursue a wholesale version, thereby leaving retail banks to cater for themselves. 

“Even then, however, banks will need to think about the implications for their balance sheets and the possible interaction between central bank digital assets and private ones, such as stablecoins,” the report further noted.

With all roads leading nowhere, one would ask how banks will navigate the impending storm. The best bet for traditional banks, as recommended by EY, would then be to take proactive steps, especially in understanding the broad direction of the regulation. 

Likewise, in addition to preparing for the worst to come, traditional banks must strive to take a seat with the central banking authority and look for how best to approach the emerging tokenomics.